Three ideas for new UK Chancellor Hammond

The UK has a new Chancellor of the Exchequer this weekend, Philip Hammond. Encouragingly he has studied at least some economics having read the infamous PPE course at Oxford, more than could be said for George Osborne who just read Modern History. Although Hammond was awarded a 1st we don’t know (yet) whether he specialised in the Politics bit (hopefully, little), the Philosophy bit (OK’ish) or the Economics bit (hopefully a lot).

The fact that he has been in business and especially property development is reasonably encouraging. He should recognise the need for nominal growth across the economy, as economic actors live in the (real) nominal world and not in artificial constructs like inflation and Real GDP.

Here are three ideas he should be considering this weekend:

Commission his UK Treasury to update the 2013 Review of the monetary policy framework. The strict inflation targeting was more or less reaffirmed but has failed to get inflation up to, let alone averaging, 2%. The grand line-up of public and private sector economists who criticised NGDP targeting should all be asked back to justify the failure of IT to deliver.

2. Downgrade the essentially arbitrary inflation target of 2% as secondary to a target of 5% growth in underlying nominal GDP. This growth rate of 5% is about right for nominal wage or income growth such that an economy has flexibility to cope with shocks and not lead to involuntary unemployment and recessions. This level will also allow much greater relative real wage and income flexibility, which in turn will allow for relatively more productive individuals and firms to be rewarded by real rises in wages and incomes, and for less productive ones to be let down gently in real terms but still grow (more or less) in nominal terms. Productivity will rise, people will be happier and you will be more popular.

2.1. If this is too much change in one step, move to a properly assessed dual target of inflation in a range of 1-3% with the flexibility coming from reference to real growth in GDP. It is imperative to stop the 2% target becoming, as it may already have done, a 2% ceiling to projections two years out.

3. Issue some government bonds tied to a 24 month moving average of NGDP or, better still, sponsor an NGDP Growth Futures market and target NGDP growth one or two years ahead. Do not target current or historic NGDP as there is always noise in that data that needs to settle down as estimates become actuals and errors corrected. CPI is an unwise target as it is an economic and politically-sensitive index that cannot be corrected for its inevitable errors – except when the whole framework is revised like with the switch from RPI.